Leverage is a term frequently used in economics and finance, yet many people are still confused about its precise meaning. Like its literal meaning, “leverage effect,” it is a strategy to create larger assets or profits with a small capital. It is widely used in financial management, corporate management, and personal investment.
Originally, leverage comes from physics, meaning “lever.” In finance, it borrows the principle of lifting a heavy object with a small force to refer to the structure of maximizing one’s profit by using someone else’s money. It involves covering only a part of investment or business capital with one’s own money and using borrowed funds to access larger assets.
For example, if you buy a property worth 100 million won with 20 million won of your own money and cover the remaining 80 million won through a bank loan, you are effectively using a leverage ratio of 5 (=100 million won/20 million won). If the property’s value rises to 120 million won, your profit is 20 million won. Since you invested 20 million won of your own money, the return on investment is 100% (=20 million/20 million×100%). Conversely, if the price falls to 80 million won, the asset’s value equals the loan amount, and your entire capital is lost.
Leverage is also commonly used in companies. Particularly in capital-intensive sectors like manufacturing or large infrastructure companies, they take on significant borrowing from the start. This helps secure growth opportunities, but if external shocks or interest rate hikes hit simultaneously, they can fall into crisis. During the global financial crisis, many companies went bankrupt due to excessive leverage.
In the investment market, leverage is commonly used in derivatives and margin trading. Individual investors seek returns in various ways, including “2x leverage” or “3x inverse” products in stocks or ETFs. These products follow 2x or 3x of the underlying asset’s yields, meaning both profits and losses are simultaneously amplified, making market forecasting and risk management crucial.
Leverage is not just “debt.” It’s a lever to pursue profit. However, if the foundation is unstable or used excessively, the losses can be even more devastating. It is essential to understand the structure accurately before use and apply it within manageable limits.
